Appreciation is an increase in value over time. In principle, any asset can appreciate. In practice, appreciation is most likely in assets with an indefinite lifespan (such as property). By contrast, assets with a finite lifespan tend to lose value over time – known as depreciation.
Examples of appreciation
In the context of business, the most common forms of appreciation are:
- Capital appreciation
- Currency appreciation
- Some businesses may also benefit from real-estate appreciation
Capital appreciation refers to the increase in value of financial assets. For example, one company may choose to sell part of its operations to another company. It may take some or all of the payment in shares of the other company. If these shares gain value over time, the first company will benefit from capital appreciation.
Currency appreciation occurs when one currency gains value compared to another currency. This is often referred to as the “exchange rate”. Currency appreciation can be a benefit if you hold reserves in that currency. If you don’t, however, it can be a drawback because it makes goods and services more expensive to buy.
If a business holds land (such as a farm) and/or property, it can also benefit from real-estate appreciation. Both land and property are in limited supply and can generally be used indefinitely. This means they generally gain value over time.
Why assets appreciate
There are three main reasons why assets appreciate:
- reduced supply
- increased demand
The term “inflation” refers to the fact that prices as a whole tend to increase over time. They do not, however, necessarily rise equally. What’s more, even with inflation, some assets may still depreciate. This is particularly likely if they have finite lifespans.
Reduced supply and increased demand can both increase the level of competition between buyers. This can translate into higher purchase prices and higher values for assets a company already owns.
How to calculate appreciation
While you own an asset, the easiest way to calculate appreciation is to use the annual percentage growth rate. To do this, take the asset’s value at the end of a year and divide it by the asset’s value at the start of the year. Then subtract one from the result and multiply the answer by 100.
For example, if an asset was worth £100 at the start of the year and £150 at the end, the calculation would be as follows.
(150/100) - 1 = 0.5
0.5 * 100 = 50
So you have annual appreciation of 50%
If you then dispose of an asset, you can calculate its total appreciation by using the Compound Annual Growth Rate.
To calculate this, take the asset’s value when you dispose of it and divide it by the asset’s value when you bought it. Then divide the result by one over the number of years you had the asset. Finally, subtract one from the result and multiply the answer by 100.
For example, if you bought an asset for £100 and sold it five years later for £150, the calculation would be as follows:
(150/100) - (1/5) = 1.3
1.3 - 1 = 0.3
0.3 * 100 = 30
So you have a compound annual growth rate of 30%.
Understanding the meaning of appreciation in business
The term “appreciation” sounds very positive. In general English, it’s used in a similar way to terms such as acknowledgement, recognition, admiration and gratitude.
In business, however, the situation is rather different. Recording appreciation on a company’s balance sheet can make it look better. Also, if assets increase in value, it may be possible to put them to work as extra collateral for financing.
On the other hand, if assets increase in value, they may cost more to insure. There may also be tax implications, particularly with real estate.